The Smart Alpha Low-Volatility Select S&P 500 Portfolio went through its quarterly refresh this week, at which time five positions were closed and six new ones were established.
Five Sales
Five stocks were sold: YUM! Brands! (YUM); IBM (IBM); Dollar General (DG); Chipotle (CMG); and Bed Bath & Beyond (BBBY). The only genuinely eventful one was for $CMG which, as discussed on February 4th, was hit by the ugly face of “event risk,” an unpredictable and unquantifiable-in-advance development that can hit any stock. The situation at $CMG has been well publicized; it involves the food-safety problems that surfaced at this high-end quick serve restaurant chain.
The other sales were uneventful and based on the model’s rules, which sometimes mean something bad happened top the company but which are often designed to close less-good positions in order to make room for better ideas that are uncovered as we go along. The latter was the basis for sales of $BBBY, $DG, $IBM, and $YUM.
Six Purchases
As we consider these purchases, it’s important to recall the goals of this strategy. I don’t care what the company did in the latest quarter, nor am I interested in what guidance was. And although this may seem counter-intuitive, I’m not aiming for “value;” as discussed previously, company quality (associated with lesser volatility) is something for which we have to pay. The model seeks company’s for which the fundamental business profile is consistent with the potential for below-market volatility.
Here are the six additions:
Colgate Palmolive (CL): This is as prototypical a low-volatility stock as one might expect. The company’s business, basic household products, has long been recognized as being “defensive,” meaning that in bad times, it’s likely to fare a lot less bad than many other businesses. (It won’t avoid downturns – consumers may price shop more aggressively, currency hits are always an issue, etc.). It’s a matter of degree and in this regard, the degree of volatility is low by virtue of the nature of the business. Needless to say, this is a competitive business (as if there’s anything that isn’t). $CL’s unique handle is its particular proficiency in global markets. It was global before global became cool. Consumers around the world know it well and the company has long been expert in managing this sort of enterprise.
Church & Dwight (CHD): This, too, is a household products company, but a much smaller one than $CL or other industry behemoths. The core of the company is its long-standing Arm & Hammer baking soda (and its association with extra cleanliness), which when added to more conventional cleaning products gives them a niche appeal. Over the years, the company has expanded its brand portfolio through acquisitions (e.g., Orajel, Trojan, Avid Health). Scale relative to industry leaders is an issue – on paper. Trailing 12 month sales for $CHD were $3.4 billion, versus $16 billion for $CL and $69.4 billion for Procter & Gamble (PG). But with CHD’s returns on equity continuing to trend up (19.9% in the trailing 12 months versus an 18.0% five-year average, compared to industry medians of 13.8% and 11.3%) and a good balance sheet (trailing 12 month interest coverage of 22.4 versus a 12.8 industry median), the company seems to be coping quite well with its theoretical size disadvantage.
